Cautious Optimism Becomes Even More Cautious
Southeastern Insights provides a broad summary of economic intelligence gathered through our network of business contacts and other sources throughout the Southeast during the latest Federal Open Market Committee (FOMC) cycle. This report covers the period from June 19 to August 1.
Information gathered through our Regional Economic Information Network is delivered to Atlanta Fed President Dennis Lockhart throughout the FOMC cycle. Our regional executives, who operate out of the Atlanta Fed's six locations and are the primary gatherers of business intelligence, participate in meetings designed to keep President Lockhart informed of regional economic developments. Also incorporated in this input is intelligence from our advisory councils, boards of directors, and community and economic development staff.
In late June, we wrote in Southeastern Insights, "Recent data and reports from the Atlanta Fed's business contacts remained modestly positive in the last days of spring." By late July, the mood had shifted. Regional economic data revealed slowing economic activity, and information gathered from our business contacts confirmed that current economic activity had slowed and the outlook had deteriorated for the second half of the year. The cautious optimism we detected in the early summer has given way to a degree of resignation that economic activity may not improve much in the months ahead. The resulting low level of expected growth is resulting in more modest hiring and capital expenditure plans, according to our contacts. In short, cautious optimism has become even more cautious.
That said, business contacts did not share plans to make significant cuts to their workforce. Most contacts said they are planning to continue operating on the assumption that demand for their goods and services will not grow rapidly in the near term. In some respects, a pickup in the growth pace may indicate some potential upside risk in that businesses are ready to expand should they experience a sustained increase in sales above their modest expectations. The downside risk, of course, is that should demand deteriorate, companies may well adjust to a lower level of activity.
Interestingly, when we asked our contacts about the balance of risks to their outlook, most respondents shared that they felt risks were more balanced than they were in June, when a majority felt risks were weighted to the downside. That may represent an onboarding of the downside risk they were expressing at that time into their actual outlook rather than any real improvement in expectations.
Looking further down the road, the longer-term outlooks of the majority of our contacts have not changed much. Most contacts anticipate improvement in 2013 from current levels of activity. However, even these longer-term outlooks appear to be a bit softer than they were earlier in the year.
The scale of this anticipated improvement is difficult to assess, as are the catalysts for a shift from the current slow-growth environment. From our conversations with businesses over the last several weeks, it's clear they are having great difficulty forecasting in the current environment. This limited visibility is resulting in a reduction or postponement in capital investment and hiring plans for several very large businesses that represent most sectors of the economy. Reasons for the decline in visibility are well known—financial uncertainty emanating from Europe, fiscal policy uncertainty mainly surrounding future tax rates and the "fiscal cliff," and a lack of clarity from regulatory agencies.
Simply said, the region appears to be in a sluggish period in an already slow-growth environment. While this makes the economy more susceptible to event risk, very few of our contacts are actually anticipating an outright decline in economic activity.
Mixed results by sector
Looking a bit deeper into some important sectors, most retailers are reporting generally slower sales, except for those tied to the tourism industry, which remains rather robust. Discount retail operations are performing a bit better than their more traditional department store counterparts. Luxury goods sales, which had been uniformly strong earlier in the year, turned a little more mixed in July but are still healthy. Restaurant operators were also less positive in recent weeks. On a more positive note, auto sales continued to grow at a solid pace.
Trucking and railroad contacts noted a deceleration in shipments and lowered expectations for the second half of the year. While contacts at regional ports said that volumes have recently surprised to the upside, few are expecting activity to increase in the coming months. Several contacts reported a falloff in shipments to Europe and Asia, but trade with Latin America remained somewhat robust.
Manufacturing has clearly slowed. The Southeast Purchasing Managers Index, produced by Kennesaw State University, fell from 51.3 in June to 48.5 in July. A reading below 50 represents a contracting in manufacturing activity. The current production component of the overall index decreased a monthly 8.4 points to 45.3. The important new orders component decreased 1.3 points in July to 47.2. Regarding future production, only 26 percent of survey respondents expected production to be higher.
Auto production, again, is a major exception to the broader slowdown in factory activity. Energy-related activity also continues to expand at a healthy pace, and significant investments in this sector are moving forward. More broadly, several large industrial projects currently in development pointed to stronger output and job growth in the near future, most notably in Alabama and Georgia.
On the issue of capital expenditure, we heard that some major firms were postponing planned investment in information technology (IT). In June, we reported that a survey we conducted showed that several respondents said they planned to increase capital purchases of IT equipment in the near future. If that outlook has changed and this spending is being deferred, it could pose a downside risk to expectations for business fixed investment. That said, other contacts have noted that IT spending was likely to remain on track because businesses feel pressure to provide consumers with regular IT upgrades. Firms also continue to invest in technology for cost savings in the face of weak demand and limited ability to raise prices.
Real estate continued to show slow improvement, although progress is not uniform. Adjusted for weather, sales of electricity to residential customers rose and new utility hookups were growing. Banking contacts reported that their mortgage business is up for both refinances and originations. Also, several of our contacts that touch the homebuilding sector are sharing reports of increases in activity, all of which may result in some potential upside risk to our residential investment outlook.
Looking at more detail, district residential brokers indicated that home sales were flat to slightly up compared with year-ago levels. Reports indicated strong sales at the middle price points, while several brokers noted that declining inventories of foreclosed homes were limiting investor-driven sales. Brokers also reported that the decline in inventories has helped stabilize home prices in many areas. Most brokers reported that home prices were flat to slightly up compared with a year earlier. However, contacts continued to note some downward pressure on home prices resulting from low purchase offers and appraisals that were coming in well below asking and offering prices. The sales outlook among brokers remained positive, with most brokers anticipating continued modest year-over-year home sales gains.
District homebuilders reported that new home sales and construction rose modestly compared with year-ago levels. The majority indicated that new home inventories declined further on a monthly and an annual basis. Most builders reported that new home prices were flat to slightly up compared with a year earlier. Price gains were strongest among Florida builders. Contacts noted that multifamily construction remained robust. In the near term, homebuilders expect sales and construction to post modest gains compared with a year earlier.
Apartment sector gains drove improvements in the district's commercial real estate markets, as occupancy rates rose and rental rates increased. The region's office and industrial sectors saw small improvements as vacancy rates moderated somewhat. However, reports on district retail real estate continued to be more mixed. The majority of commercial contractors said that construction activity was flat on a year-over-year basis. The majority of contacts anticipate a modest increase in private commercial construction activity through the remainder of the year, while public works projects are expected to decelerate.
Labor markets stalled
We detected very little movement on employment, which may reflect firms having limited visibility on what the future holds. As we pointed out earlier, many of our contacts noted with frustration that their forecast horizons have become shorter and shorter.
Recent data on regional employment have been disappointing as well. The Sixth District as a whole shed a net 11,100 jobs in June, following a small gain of 7,700 in May. Data for July will be released on August 17.
The decline in Tennessee's total payroll employment was largely a result of a 15,300 decline in government employment. Large declines in June government employment have been recorded in previous years as well in Tennessee, so taking this trend into account, the overall reading for the region was not so negative. Nonetheless, job growth remains anemic in the Sixth District.
The district unemployment rate, which is an aggregate of the six states in our region, rose to 8.5 percent in June from 8.3 percent in May. With the exception of Florida, which held steady at 8.6 percent unemployment, all states in the region reported increases in the unemployment rate over the previous month.
The idea that the mild winter and firms' "staffing up" to make up for deep cuts made during the recession contributed to unseasonal employment gains has been largely confirmed in our conversations with business contacts over the past several months.
Contacts continued to note difficulty in finding qualified applicants for many highly technical positions, and some reported problems finding candidates for some lower-skilled positions. Many manufacturing and trucking contacts continued to note challenges in attracting applicants with the necessary skills. The skills mismatch problem has been especially hard on low-wage individuals, according to community and economic development contacts.
Prices appear stable
We also found little movement on prices. Businesses reported some relief on input prices and little change in wage plans, although some employers noted that they were increasing starting pay for workers with high-demand skill sets. We did not hear reports indicating that there was downward pressure building on prices or wages. Firms responding to our July Business Inflation Expectations survey reported steady unit cost expectations: survey respondents indicated that, on average, they expect labor and material costs to rise 1.7 percent over the next 12 months. While it was the same as June's reading, that number is down from 1.8 percent in May and 2.1 percent in April.
The Southeast experienced very modest growth in economic activity in late June and July, and business expectations deteriorated. Employment growth slipped and unemployment rates edged up. Prices were largely stable. The region is clearly not performing as well as it did earlier in the year, and we detected little that leads us to believe an improvement is imminent. That said, we also cannot conclude that the recent deceleration in regional economic activity will turn into an outright decline.
By Mike Chriszt, a vice president in the Atlanta Fed's research department, and Shalini Patel, a senior economic research analyst